iFiduciaries of Employee Stock Ownership Plans (ESOPs) and other retirement plans that include employer stock have generally been able to rely on a “presumption of prudence” in lawsuits brought by participants challenging the fiduciary’s decision to purchase employer stock or offer that investment option. Such lawsuits, often called “stock drop” suits, have become popular amongst the ERISA plaintiff bar when the employer stock has substantially declined in value, reducing the value of participant accounts. Over 200 stock drop cases have been filed nationwide, most following the Enron and Worldcom scandals and global financial crisis.
In Fifth Third Bancorp v. Dudenhoeffer, decided June 25, 2014, the U.S. Supreme Court held that there is no special presumption of prudence applicable to fiduciaries with respect to employer stock. The Court has, however, provided important guidance to fiduciaries in connection with employer stock investments and has provided instructions to lower courts to use in evaluating such lawsuits.
Background
In Dudenhoeffer, former employees brought suit against Fifth Third Bancorp. The plaintiffs alleged that the fiduciaries of the Fifth Third’s ESOP breached their ERISA duty of prudence by continuing to invest in employer stock that the fiduciaries either knew or should have known was inflated in value, and which subsequently lost almost three-quarters of its value. The district court held that the plaintiffs’ allegations were insufficient to overcome the presumption of prudence developed in case law, often called the “Moench presumption,” and dismissed the case. The Sixth Circuit reversed, reasoning that the presumption did not apply at the pleading stage.
In taking the appeal, the Supreme Court considered various arguments in favor of the presumption developed by the lower courts. Specifically, the Court considered whether the presumption should apply because 1) it is consistent with the intent of Congress in fostering employee ownership of employer stock; 2) the Fifth Third ESOP plan document required fiduciaries to invest in employer stock, effectively waiving the duty of prudence with respect to that investment; 3) enforcement of a duty of prudence without the protection provided by a presumption would create an inherent conflict with prohibitions on insider trading; and 4) without a presumption of prudence, frivolous lawsuits would abound, which would deter companies from offering ESOPs.
No Special Presumption of Prudence Provided by ERISA Statute
In its unanimous decision, the Court determined that there is no special presumption of prudence uniquely applicable to fiduciaries with respect to ESOPs, or the decision to offer employer stock as an investment. In reviewing the statute’s provisions, the Court ruled that ERISA alleviates only the duty to diversify within an ESOP and alleviates the duty of prudence only with respect to ERISA’s diversification requirements. The Court refused to find a larger presumption of prudence from these more narrow provisions, holding that ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the fund’s assets.
With respect to the argument that the plan document mandated an investment in employer stock and that the fiduciaries could not ignore those provisions, the Court found that the documents cannot excuse fiduciaries from their ordinary fiduciary duties under ERISA.
In its decision, the Court did not close its eyes to the inherent conflict often faced by fiduciaries. Indeed, the Court noted that, without a presumption of prudence, fiduciaries, who are often company insiders, will be faced with conflicts between their responsibilities as fiduciaries on the one hand, and their obligations under securities laws on the other. For example, an officer with insider information who believes that continued investment in employer stock may not be prudent could not act on that information without violating insider trading prohibitions. The Court found that this was a legitimate consideration, but not one that created the necessity of a general presumption of prudence absent Congressional authorization.
Finally, with respect to the argument that, absent a presumption of prudence, participants might be more inclined to bring meritless lawsuits, the Court acknowledged that this is also a legitimate concern and that district courts could address this through careful scrutiny of the complaint’s allegations, rather than by creating judicial presumptions.
Guidance for Lower Courts and Plan Fiduciaries
Accordingly, the Court’s opinion provides a roadmap for lower courts to use in determining whether plaintiffs have stated a plausible claim for breach of fiduciary duty. The Court instructed the lower courts that only a complaint that states a plausible claim for relief can survive a motion to dismiss, and that determining whether a complaint states a plausible claim for relief is context-specific.
In making the determination whether claims are plausible, the Court discussed how a fiduciary’s duties might be affected by publicly available information about the company’s fortunes as well as how those duties might be affected by their possession of insider information.
In a ruling which should be helpful to fiduciaries, the Court stated that a lawsuit alleging that a fiduciary should have recognized from public information that the marketplace was either over- or under-valuing employer stock is “implausible as a general rule,” absent special circumstances. As a result, generally a fiduciary will be not considered imprudent when assuming that the market value of employer stock on a major exchange is an accurate estimate of the stock’s value. The Court did not elaborate on what circumstances might give rise to a situation where reliance on the stock price as set on a public exchange might not be considered prudent.
A claim for the breach of the duty of prudence on the basis of inside information will not withstand a motion to dismiss unless the plaintiff plausibly alleges another course of action that the fiduciary could have taken. To be plausible, the course of action must be one that does not violate securities laws. Also, the course of action must be one that a prudent fiduciary would not have viewed as more likely to harm the employer stock fund than to help it (including situations where a prudent fiduciary would conclude that ceasing investment in employer stock, or selling stock, would have caused or worsened a decline in the value of the stock already in the fund). The Court suggested that U.S. Securities and Exchange Commission (SEC) input on this aspect may be relevant to the analysis.
In sending the Dudenhoeffer case back to the lower courts, the Court observed that the Sixth Circuit had not referenced any special circumstances that would have rendered the fiduciaries’ reliance on the market price of Fifth Third stock imprudent. It also noted that, to the extent the Sixth Circuit was basing its decision on the theory that the fiduciaries should have acted on insider information, the denial of dismissal was erroneous because ERISA’s duty of prudence cannot require an ESOP fiduciary to perform an action, such as selling employer stock on the basis of insider information, that would violate federal securities laws.
As a result of the Dudenhoeffer decision, courts must closely scrutinize stock-drop complaints to determine whether they state a plausible claim for breach of fiduciary duty by ERISA fiduciaries. While the principles identified by the Court will be fleshed out in future lower court cases, it is clear that stock drop plaintiffs will be forced to narrow and otherwise refine their claims. Fiduciaries, on the other hand, will have several potential defenses available to them to attack these suits at the initial pleading stage, as well as upon summary judgment and trial.
